Debbie, a successful businesswoman, informs her new boyfriend that she keeps a duffel bag with eighty thousand dollars in cash hidden in her closet for an unexpected need. “Might come in handy for the zombie apocalypse,” she adds.
This scene from a gripping crime drama I watched the other night made me of think of purchasing power. Let’s set aside the wisdom of leaving cash in a duffel bag and then telling a guy you just started dating about it. I wondered, “Would Debbie be able to afford the zombie apocalypse when it came to pass. Might Debbie lose purchasing power?”
What is purchasing power or buying power? It’s the ability of a unit of currency to buy goods. I’ll use a very personal example to describe this. I remember distinctly that over 30 years ago I could get a can of soda in the vending machine at my local athletic club for 50¢. Today there is nothing worth 50¢ in the gym vending machine. Not even the filtered water. Or a pack of gum.
This example is probably not surprising to anyone reading this. So why is it then that many institutions and individuals don’t consider this phenomenon when setting funds aside for an unspecified project, event or endeavor that could happen in well over a year? They hold large quantities of cash in a checking account earning nothing. Even a standard interest-bearing savings account like the one my bank offers – 3 pennies per year for every $100 deposited – will not generally keep up with the rate of price increases or inflation.
Consider these real-life examples of purchases planned after 3 years:
1. The nonprofit sitting on cash to pay for its anniversary party.
2. The institution sitting on cash toward a down-payment on a new facility.
Let’s compare each example in detail from Ian Webster’s inflation calculator which references national raw data national from the US Bureau of Labor Statistics’ Consumer Price Index (CPI). We’ll use the round number of $100,000 for simplicity’s sake.
The above table shows the average inflation rate of two categories of goods and how it affects the price from 2016 to 2019 based on the average. Notice that inflation rates vary depending on the category of goods. For example, $100,000 of food and beverage in 2016 will cost $104,000—an additional $4,000—for the same basket of food and beverage. Also $100,000 of real estate in 2016 will cost $110,000 for the same real estate property in 2019. Organizations that have future expenses typically will have to supplement the cash they’ve put aside. That supplemental cash will have to come from future operational income, donations or from investment growth. A prudent institution or individual will factor in potential inflation and the time to purchase when putting funds aside for a future expense.
Getting back to Debbie and her duffel bag of emergency cash. In this case you don’t know a) when you need the funds, b) what you might need the funds for and c) what prices will be for this unknown expense. To be clear, these are funds you don’t need for everyday operations or living expenses but need immediately accessible in the event the unexpected incident strikes. Now you want two things with this cash: it needs to maintain purchasing power AND it needs to be liquid.
What does it mean to have liquid funds or liquidity? Liquidity is the ease at which an asset can be converted into goods and services without significantly affecting the price. Cash is considered the most liquid financial asset as it will be accepted in almost any transaction and can be converted almost immediately. Assets such as art or real estate are very difficult to convert into goods and services and are therefore considered illiquid. Funds put aside for an emergency, or Debbie’s zombie apocalypse, should be liquid as well as maintain purchasing power.
If you feel safest holding your cash in a checking account or some other account not at all keeping up with an average 2% inflation for all goods, then you should try to add 2% new funds to your emergency stash every year. This is in effect like paying for your own interest. Alternatively, you can hold your funds in a savings account or money market account that yields closer to that average 2% inflation rate to help maintain purchasing power.
So if you’re looking to set aside funds for an event that could happen in over a year, try to maintain its purchasing power over time. And please put it somewhere besides a duffel bag.
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